During his keynote presentation at the Morningstar Investment Conference, the PIMCO manager made the case that high debt levels and a need for financial stability mean that centralbanks should keep real rates close to zero for some time.

Roundtable Report: At the outset of 2014, Morningstar strategists dig into the market's current valuation and expected return, seek out high-quality U.S. and foreign stock opportunities, size up the role of cash today, assess theFed's impact on the market, and reveal the best ways to fight inflation .

This article represents opinions of the author and not those of his firm and are subject to change from time to time and do not constitute a recommendation to purchase and sale any security nor to engage in any particular investment strategy. The information contained here has been obtained from ...

To many people, the way money works and its link to inflation is rather mysterious, despite its obvious importance in the economy. We take it for granted that the dollar bills in our wallets can be exchanged for goods and services, but what determines their value? Why does a Big Mac cost $3.45, and not $345?

Most people think of inflation as the price of goods and services rising, but really inflation is about the value of money going down. So, if we want to think about inflation or deflation, we have to think about what gives money its value. Are dollar bills intrinsically worthless pieces of paper that are nevertheless valued simply because everyone believes them to be valuable? Or is money perhaps a government liability, backed by an implicit guarantee that the government will be there, if necessary, to accept it in exchange for something of real value?

To get the answers to these questions, we invited two distinguished experts to Morningstar’s Chicago offices on June 8: John H. Cochrane and Harald Uhlig. Cochrane is the AQR Capital Management Distinguished Service Professor of Finance at the University of Chicago Booth School of Business. Uhlig is a professor in economics and the chairman of the Department of Economics at the University of Chicago.

Before we get into our discussion about money, we need to define what money is. Money is basically an asset, just like a stock or bond. It is an asset, however, with some particular characteristics. It is both a unit of account and a medium of exchange. There are different types of money. The monetary base is money issued by the Federal Reserve, a bank owned and run by the federal government. Part of the monetary base exists in physical form (dollar bills and coins), or currency. The rest is electronic, or reserves, which are accounts that banks have at the Federal Reserve.

People tend to hold a fraction of their wealth in the form of money, because we need money to purchase goods and services and we obtain money when we sell them. How much money we hold depends on money’s returns. If the returns to holding money are very low (compared with other investments), we try to hold less money. This low return occurs during inflation, when money is losing value quickly. Conversely, people are willing to hold a lot of money during a deflation.

How much money we hold also depends on the overall level of economic activity—how much we’re buying and selling—and the costs of exchanging money for other assets. To hold very little money, you have to make a lot of trips to the ATM. Finally, people choose to hold a lot of money when the risks of holding other assets seem very high. We saw a massive increase in money demand during the financial crisis.